Last year was not a good one for commercial aerospace companies. The COVID-19 pandemic essentially shut down global air travel for more than half the year. This year shows signs of a turnaround in commercial travel that should begin to put several major industrial firms on the road to recovery.

In the defense and government services industries, however, the outlook is somewhat mixed. Stocks in big defense contractors have reached a 20-year valuation high, always a precarious perch for further gains. Companies specializing in providing cloud services, cybersecurity and a handful of other leading-edge technology could see more share price gains.

These considerations fed into an aerospace and defense industry update by analyst Matthew Akers at Wells Fargo Securities. Akers has initiated coverage of 14 aerospace and defense companies, six of which received an Overweight rating. Of those, three show potential upside of 20% to their current share prices and the other three show upside potential of between 13% and 18%.

CACI

Of the three top-rated services companies, CACI International Inc. (NYSE: CACI) is the one that Wells Fargo expects the most from. The stock is rated Overweight with a price target of $311 and upside potential of 20%. CACI’s multiple software offerings in business solutions, command and control, unified communications and cybersecurity make it the top pick overall among hedge fund managers, long-only investors and sell-side analysts.

Akers writes, “CACI’s focus on technology could help expand its addressable market while also supporting margins. We believe its pivot to a more balanced capital deployment strategy makes sense in light of market conditions …”

The stock traded higher Thursday morning, up about 1.8%, at $258.64 in a 52-week range of $190.16 to $266.31. CACI does not pay a dividend, and the consensus price target is $298.50. The company’s market cap is about $6.1 billion, and shares are lightly traded, with an average daily volume of less than 250,000.

Howmet

Specialty metals and machinery company Howmet Aerospace Inc. (NYSE: HWM) spun out of Arconic in April of 2020 and the shares have risen by more than 140% since then. Wells Fargo rates the shares as Overweight with a price target of $39 and a potential upside of 20%. Howmet benefits “from strong incremental margins as aerospace demand ramps up post COVID.” The stock is the top pick among hedge fund managers and sell-side analysts.

Howmet shares traded up about 2.3% early Thursday, at $32.60 in a 52-week range of $9.897 to $33.89. The consensus price target on the stock is $38.43. The company does not pay a dividend, and the average daily trading volume is about 3.1 million shares. Howmet’s market cap is around $14.3 billion.

TransDigm

TransDigm Group Inc. (NYSE: TDG) supplies aircraft components to both the commercial and defense markets. Wells Fargo rates the stock as Overweight with a price target of $718 and a potential upside of 20%. Over the past 12 months, the stock has added about 79%, but since late November the shares have traded in a fairly narrow range.

Akers thinks that the company’s exposure to the commercial aftermarket will help it recover faster, “driving top line growth along with better margin mix.” He sees the company as capable of maintaining cost cuts made during the pandemic, “providing an additional tailwind to profitability.”

Its shares traded up about 2.2% to $591.19, in a 52-week range of $303.51 to $633.04. The company does not pay a dividend, and the consensus price target is $681.87. TransDigm’s market cap is around $32.4 billion, and the stock is lightly traded, at fewer than 300,000 shares on average daily.

Booz Allen Hamilton Holding Corp. (NYSE: BAH) provides management and technical consulting services to governments, corporations and nonprofit organizations. Wells Fargo has given the stock an Overweight rating with a price target of $96, implying upside potential of 18%.

Akers’s story on the stock is clear: “We see BAH continuing to outgrow peers organically, driven by outsized exposure to key technology areas such as Cyber, Cloud, and AI.” Valuation has also dropped back “to the midpoint of its range over the past few years, from a large premium in 2020.”

The stock traded up 2.4% to $82.65 on Thursday, in a 52-week range of $68.34 to $100.26. Booz Allen pays an annual dividend of $1.48 (yield of 1.83%) and has a consensus price target of $92.09. The average daily volume is about 1.1 million, and the company’s market cap is about $11.4 billion.

Leidos

Leidos Holdings Inc. (NYSE: LDOS) is another services company getting an Overweight rating from Wells Fargo. The company’s price target is $120, and the upside potential is 15%.

In late December, Leidos finally cleared its win for an $8 billion contract to upgrade the U.S. Navy’s enterprise network, known as NGEN. Akers writes, “We believe LDOS will outgrow its peers in 2021 driven by its NGEN program ramp, COVID-19 impact subsiding and Security, Detection and Automation business recovery along with recent acquisitions.” Leidos’s scale is also “a larger differentiator than many may realize as federal contracts data appear to show the government is consolidating many smaller programs into large contracts over time.”

Leidos shares traded up about 1.6% Thursday morning to $103.04, in a 52-week range of $79.15 to $113.75. The company pays an annual dividend of $1.36 (yield of 1.34%). The consensus price target is $117.70. The average daily trading volume is around 1 million shares, and the company’s market cap is right around $15 billion.

General Dynamics

Among the five defense contractors in Wells Fargo’s coverage, General Dynamics Corp. (NYSE: GD) is the only one to earn an Overweight rating. With a price target of $216, the company’s upside potential is 13%.

Akers says, “We believe GD’s defense portfolio lends itself to above-peer growth in the coming years, driven by shipbuilding programs, along with a relatively positive Procurement/RDT&E [Research Development Test & Evaluation] mix as Columbia [ballistic missile submarine] transitions to production.”

Shares traded up about 1.9%, at $190.33 in a 52-week range of $129.11 to $197.51. General Dynamics does not pay a dividend, and the consensus price target is $193.65. The average daily trading volume is around 1.2 million shares. The company’s market cap is about $54.5 billion.

Here are the other eight stocks included in Wells Fargo’s coverage of the aerospace and defense industry:

• Boeing: Equal Weight with a price target of $244 and 7% upside potential
• L3Harris: Equal Weight with a price target of $225 and 5% upside potential
• Woodward: Equal Weight with a price target of $130 and 4% upside potential
• Raytheon: Equal Weight with a price target of $87 and 3% upside potential
• SAIC: Equal Weight with a price target of $95 and 7% upside potential
• Lockheed Martin: Equal Weight with a price target of $384 and 1% downside potential
• ManTech: Equal Weight with a price target of $83 and 1% downside potential
• Northrop Grumman: Under Weight with a price target of $330 and 10% downside potential

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